Sunday, November 4, 2018

Has Buffett Lost It?!

Wow.  Apple (AAPL) was a $28 billion position at the end of 2017, with 167 million shares, but now BRK owns 252 million shares as of the August 13-F (November will be out soon), for a position size of  $47 billion then and $52 billion now (as of 11/4/2018).

That sounds crazy as it's the largest position ever, and it's a 'tech' company. OK, maybe it's a consumer products company and not a tech company. Either way, wow, that's a big bet, exceeding 10% of the market cap of BRK.  Well, for focused investors, 10% is not such a big deal, and even 25% of the equity portfolio may not be that crazy as AAPL isn't some obscure micro-cap, or over-leveraged industrial cyclical or anything like that.

But, I am not the biggest fan of AAPL, so it is interesting. Coming right off his IBM miss, I guess many shareholders would be a little surprised.

Of course, I don't recommend it, but this is an easy position to hedge against; you can just short AAPL shares against whatever BRK owns.

Here is the 13-F from August; I only show positions of more than $10 billion here:

You can get the whole sorted table here.
(oops, the above link shows an error for some reason. You can click 'website' below and then just go to the 13-F section and click BRK).

I know a lot of stuff on the website is broken. When I have time, I will fix it and maybe add some stuff to it. When Google finance/Yahoo finance dropped their financial data API's, a lot of things broke and it got to the point where I would have to pay for data to update stuff, and I don't want to do that. I recently noticed that a form of the Yahoo Finance API is back up, so I will be able to update some stuff, but I will have to rewrite a lot of the code, so I am in no rush to do it at the moment (I have a lot of work I need to do for others etc...  this stuff goes to the back of the queue, unfortunately).

The bull and bear argument has been the same for years, so I don't want to get into it again here, but I feel like AAPL has sort of been chasing the crowd lately rather than leading it or disrupting it like they used to during the Jobs years. But again, this would get the AAPL fans all fired up and angry, so maybe I'll leave it at that. I'll just say that moving up to higher end products to make up for declining growth momentum reminds me of retailers/restaurants that hid declining traffic/unit volumes by moving up-market or raising prices. It works for a while until people finally say, no mas, and will no longer pay high prices. Sort of reminds me of J. Crew, P&G etc.

The Markets
The markets have been going nuts too. Well, I don't mean to imply that Buffett has gone nuts, really. AAPL has a strong brand name/franchise, high returns on capital, decent margins, too-strong balance sheet, repurchases a lot of shares etc. So a lot of the boxes are checked in this case. Can't blame someone for buying a company like that.

The markets can be down hundreds of points overnight, but then be up hundreds by the close (if not an hour after the open), and vice versa. It has always been meaningless to stare at the market during the day (and futures overnight), but it seems even more so these days. I guess bots can be part of it. Risk parity is probably also a part of it. Leveraged ETF's. In any case, it's important to remember that we shouldn't be responding to markets. You should never be selling anything when the market is down 800 points. That's just obvious. If anything, if you have something to buy, you should be buying. But if you sit there and stare at the markets or otherwise follow it too closely, all sorts of bad thoughts can go through your mind. If it is too upsetting or scary, just turn off the TV, or don't look at the market for a while. It's like the weather in Amsterdam; if you don't like it, just wait. It will change. (Did I get that right?)

Interest Rates
I hear all the time that interest rates are going up so the market must go down, but all of my work in previous bubble posts were based on the baseline assumption that the 'normalized', sustainable long term interest rate is probably around 4.0%. Using a lot of historical data, I showed that if the long term rate averages 4% over the next 10 years, the market could easily average a P/E ratio of 25x over that time frame. This is not a prediction, of course. It's just an observation based on history: if it's not different this time, and if interest rates average 4% over the next 10 years, then, based on history, a 25x P/E would be completely normal.

Yes, this is basically the Fed model, which has been a subject of debate if not completely discredited by some. One debate is that the relationship between P/Es and interest rates held only for a brief period in time and not for the whole 100+ years of recent history, but my feeling is that since interest rates were regulated for much of the early 20th century, it's hard to say if there is any meaning in the lack of correlation going too far back in history. The other argument is that P/E or E/P is 'real' whereas bond yields are not. But this argument only strengthens the above argument. A low E/P is even more attractive than a low bond yield as the E will increase with inflation whereas the bond yield will not.  And comparing earnings yields to the TIPS yield (which would take care of the real versus nominal problem) would just be silly as the TIPS yield 10 years out is 1.2%, suggesting a P/E multiple of 83x

So, watching the market throw conniptions because interest rates went above 3.0% didn't worry me at all. I thought, OK, well, whatever. All else equal, higher rates may equal lower equity prices, so people dump stocks when rates go up. But as I've said in my bubble posts, I don't see the rubber band stretched at all, so the market is not in need of a violent correction. Of course, if we are on our way to 6-8% long term rates, then that's a different story.

When markets go crazy like this, people tend to ask me about hedging. Well, first of all, hedging is something to do before the market goes down, not after. It's interesting that people start to want to hedge after the market starts to go down and volatility goes up (hedging costs go up).

I've spent a lot of time in the derivatives business, and a lot of it is about hedging. There are a lot of good and valid hedges; interest rates, FX, commodity prices etc. But when it comes to the stock market, a lot of hedging is baloney. Some large institutions may use futures to synthetically adjust their asset allocation (sometimes cheaper than selling stocks, paying taxes and buying something else).

But when it comes to just directional hedging of the stock market, I think more money has been lost trying to do that over the years than any money actually lost in the stock market. I know for sure that if you try to hedge a stock portfolio with futures, options or swaps, it's going to cost you. If you need to hedge your portfolio using any of these, most of the time, you are just better off lightening up your position and forget about hedging. If you feel like you need to hedge your portfolio with put options, you probably just own too much.

If you hedge all the time, it's going to be very costly. I'm not going to do it, but just go look at some put option quotes on the S&P 500 index, for example. And imaging rolling that over every three months, or every year. It is not cheap at all. And if you think you can time it and put on hedges only during risky times, well, that usually doesn't work out either. Some very good investors thought the market was expensive a few years ago and hedged their portfolios and it was a disaster. Even the smartest can't time their hedges.

If you look at how wealth is built up over the years, most of the time, it's been created by people who hold very good assets for very, very long periods of time. Nobody gets rich by being very good hedgers of their portfolios. OK, there are some hedge fund managers who have done it over the years, but that's pretty rare. Most other people, if you look at the richest people list, just own good assets and don't try to get in and out according to how they feel about the market or the economy.

In a sense, people like Buffett and Bill Gates are kind of lucky in that they can't get in and out of their positions anyway, even if they wanted to. Imagine Gates calling Goldman Sachs, "I want to put on a zero-cost collar on Microsoft because I don't like where we are going in this economy!". Nope. Won't happen. I know hedging CEO holdings used to be a big business for derivatives desks a while back; maybe it still is. But if you look at the guys who create tremendous wealth, most of the time, they just own and hold onto great assets for long periods of time.

Real estate wealth is built the same way (but they get leverage, and their buildings are not marked to market so they never get margin-called; that's a huge advantage versus leverage in the stock market). They can't just buy and sell futures, options or swaps against their holdings. And they can't trade their buildings short-term either.

As I've said before, the stock market suffers a sort of "curse of liquidity". Since you can just liquidate your entire portfolio by pushing one button on your iPhone (OK, well, maybe not some rich people, but many of us can...), it is easy for us to do stupid things. And you can see how much you are losing every second of the day on your iPhone. You can't do that with real estate; there is no way to tell exactly what it is worth until you put it on the market and get some bids. In other words, there is no manic-depressive Mr. Market knocking on your door every micro-second in real estate (unlike stocks) tempting you into doing stupid things. So 1. there is no stupid-behavior-inducing signals (crashing prices) and 2. there is no way to act immediately on impulse in the real estate market. Most people would do better in the market if they treated their equity portfolio like their home.

What a total disaster GE is. I've always admired GE and it was one of those companies that I really wanted to like and wanted to own, but it never quite worked for me. First of all, Jeff Immelt must be the worst CEO of all time. OK, there are CEOs that bankrupted companies, committed fraud etc. So in that sense, maybe he's not the worst. But as a non-criminal, blue-chip CEO, he's got to be one of the all-time worst. And it's not just about the stock price; the businesses are just horrible. It looks like he stood up and got hit with a left hook, ducked to avoid the next shot only to get a big upper-cut to his chin. Whatever he did seemed just wrong.

I remember when Buffett was talking about CEOs, and this was around the time that Irene Rosenfeld sold the frozen pizza business for cheap and overpaid for Cadbury. He was talking about how many CEOs are great operators but many have issues with capital allocation. We all thought he was talking about Rosenfeld, but it didn't occur to me that he was probably also talking about Immelt.

He often said how wonderful Immelt was as a CEO but never actually bought GE stock (or in any size that I can recall; it was never a top holding), and I always wondered about that. In hindsight, well, he was probably also talking about Immelt.

GE is really tempting now at under $10, and the CEO is a really good one, but I'm not sure how GE gets out of this. Frankly, I haven't taken a close look at this in a while; maybe I will. If I find anything interesting, I will probably make a post here. But I just don't like (and never liked) the businesses these guys are in. It's mind-boggling how Immelt just seemed to run the other way than the world was moving.

Has Buffett Lost His Mind?!
OK, so back to Buffett. Has he lost it? Is he buying more AAPL shares? Does he need intervention? Should he undergo some tests to make sure he is OK?

I have no idea. I'm sure he is fine, and all accounts (from the annual meeting etc., and is interviews on TV) seem to indicate he is fine.

I guess AAPL is so big because it's the first time in a long time that he really got to like something and it was large enough so that he can actually buy a ton of it. Remember, he was capped at 10% on Wells Fargo due to bank regulations.

I own BRK, and I don't really like AAPL, but I'm not going to hedge out the AAPL piece.

We'll see.